You may have heard the term ‘venture debt’ thrown around in recent years, but what does it actually mean? By definition, venture debt is a type of debt financing provided mainly to venture backed companies by specialised lenders to fund working capital, runway, growth projections, M&A and more.
Originating in the US in the early 90’s, venture debt has changed quite significantly over the years. Most commonly known for being money before or with an equity round, venture debt often had significant equity warrants and aggressive repayment profiles. Today, venture debt is used more as an umbrella term, and it can take many forms. However, there are still many common misconceptions about this alternative financing option, leading people to miss the benefits venture debt can offer.
Many believe venture debt is available exclusively for profitable companies. This is false; most of our clients are cash intensive, loss making businesses choosing to reinvest in the business to acquire market shares or investing in their IP, software and people. Secondly, people are often of the view that venture debt only comes with aggressive warrants, and that they’ll have to give away a fair share of their company. While this often used to be the case, some funds now don’t take warrants at all. It’s all about finding the right option for your situation. People also often believe venture debt has restrictive covenants. Again, this isn’t always the case; many funds will provide solutions with zero covenants attached.
The pandemic has rapidly accelerated the demand for venture debt. The economic downturn caused by the pandemic has increased the profile of venture debt as many companies looking to extend runway start turning to alternative sources of financing. According to Pitchbook, many companies “may turn to debt financing as an alternative to traditional equity rounds, as they attempt to avoid down rounds, dilution, and unfavorable terms”, so it’s certainly a financing method worth becoming familiar with.
The benefits of venture debt extend to both VCs and founders. It is a non-dilutive option, cheaper than equity, flexible and tailored to your needs, and involves rapid execution and evolving facilities. It also typically constitutes a mezzanine finance option to compliment equity raise options, providing a very efficient cost of capital. For VCs, venture debt allows you to leverage investments, adding firepower to the table without increasing exposure, as it is a non-dilutive option. For companies, the most attractive benefit of venture debt is that it provides funding without dilution and without covenants.
When executed in the right way for the right type of company, the key benefits of venture debt are:
Runway - Leveraging a recent round to take full advantage of the “honeymoon period” to double down on runway with a debt element to complement your capital structure.
High Growth Potential - In specific scenarios, debt can be used to extend your runway outside of any equity events. Your customers, clients, long term contracts and IP can be perceived as great assets by lenders.
Efficient Cost of Capital - For a fast growing business, cost of capital is an important consideration. If your business is growing at an annualised rate greater than cost of lending, then debt works out cheaper than equity dilution.
When looking to grow your business, it’s important to consider all the options available to you. With the right support and guidance behind you through the help of a specialist advisor, the venture debt process is surprisingly simple, often executed in a three month period, unlocking facilities tailored to suit your needs. For instance, if you were to undertake the venture debt process with the Elevate team, we would shield 90% of management involved in the process. Capital raising can be time consuming, and Elevate is here to support you in securing the right finance partners for Venture Debt.
It’s fundamental to onboard a specialist advisor to screen the market for you to ensure you get the best deal available out there. If you’re interested in learning more about how we could help you with this option, reach out to the team for a no obligation chat.